February 17, 2011

Value and Volatility in Today's Markets, Plus What We're Watching Now

In the equity markets, stock values are higher and volatility is lower, as we have seen over the last two years. Not only is this a true statement, but it was made by Ben Bernanke, the Chairman of the Federal Reserve on February 3, 2011. This in and of itself is very intriguing. Does Ben actually trade the markets and the VIX as well?

I want to comment on this a bit. First, it is not my understanding that the Fed's job is to monitor the equity markets and to gauge the health of the banking industry by stock valuations.

Secondly, I believe if they are supposed to monitor any sector of the overall markets, perhaps starting with the KBE, or the XLF would be a good start. After all, the Fed's main job as an independent entity is to regulate the nation's financial institutions. The primary responsibility of the Fed is devising and implementing monetary policy.

The chart below on the financial sector exchange traded fund (XLF) shows that the overall sector has not only yet to break out above April 2009 highs, but it is at lower levels from that point in time. In addition, the recent rally since the beginning of the year was on lighter volume, and now as we enter mid-February, this sector is showing a tendency towards price weakness.

The next chart is on the S&P 500 futures, and as you can see we clearly have made substantially higher highs as we broke out above the April 2009 highs. Since the beginning of the year, the overall market has appreciated on pretty decent volume. We are entering a period where historically we see a market correction, as my seasonal indicator shows. So if the economy is doing so well, why has the financial sector, the area that the Fed is responsible for, not in sync or participating in tandem with the overall stock market rally? More important, if we do see an overall stock market correction soon, how much will that drag the financials sector down?

I could be wrong here, but I believe the Fed should not be justifying their actions of pumping excessive liquidity to the banking system from Quantitative Easing (QE) both in part I and especially in part II by measuring the pace and health of the benchmark indexes such as the S&P 500 or the Dow Jones Industrial Average.

As a trader, analyst, and educator in the field of technical analysis, I look for opportunities in high beta stocks tied to seasonally strong sectors. In late 2010, we recommended bank stocks, such as Citi (C), Bank of America (BAC) and US Bancorp (USB), and even region small cap back stocks like Susquehanna (SUSQ).

While most of these stock trades were profitable, some were not filled on our entry, our the decision was correct to enter the bank stock space as we found value during a seasonally strong time frame.

Since then, many of these stocks have either failed to trade higher or at least much higher from our exit prices. The point is as the overall S&P 500 index reaches over a five percent year-to-date gain, the financials have not participated in the move. A situation to consider is that either the overall stock market will decline as we enter a seasonal weak period or the financials will play catch up. My opinion is we will see a correction, and hopefully drag financials lower, giving us a prime buying opportunity.

However, until one or the other starts to tip their hand as to which outcome will occur first, we are cautiously optimistic here at PA Stock Alerts.

The fact is we are long selective stocks in seasonally strong sectors like oil and oil services. One of our holdings, Atwood Oceanics (ATW) gave us a five percent net gain the first day we entered the trade. As a trade we took half off, moved our stops to break even, and since then the stock is up another five percent!

The following chart shows that from a seasonal perspective, we see continued strength for a few more months. In addition, the latest breakout is on solid volume and last week the market broke out and made a solid new two-year closing high. This should attract momentum traders helping to further boost prices.

Our current holdings also include Masco Corp. (MAS), which is in the materials and building products sector. Seasonally speaking, this company is also in a seasonally strong period until the end of April and while it is not near its April high, the volume studies show heavy participation when prices rise, which is a healthy sign.

Our next stock, Conceptus Inc (CPTS), is in the health care equipment space. As the chart below shows, this company is no where near its 2009 highs, but the market is in a strong seasonal time period.

The stock made a recent weekly closing high on relatively decent volume. Although I would like to see stronger price action on increasing volume, the stock certainly has great potential.

All of these stocks are currently profitable and they were selected based on several search criteria built on both John and Tom's proprietary research. One thing that is for certain, these stocks and sectors are in seasonally strong time periods.

The question is now: with the overall stock market climbing to new two-year highs, is the rally sustainable? Moreover, if the economy is either expected to start firing on all cylinders and if traders suspect more jobs will be created in 2011, plus if the construction, housing and commercial property sectors improve, why aren’t banking stocks or the financials sector participating as compared to the benchmark S&P 500?

The key is--should we be looking to reenter banking stocks now or any other stocks we were in?

That is a great question and one which we want to explore more. In fact, many traders can probably relate to what I call PTR syndrome (profit taking remorse syndrome). I can’t tell you how many trades I look back on one month or twenty years later and say,”boy I should have held on longer”!

I will give you one trade that sticks out in my mind. Last June right before we launched PA Stock Alerts, a buy signal came up on my criteria search on this particular company. I had never heard of them, the time was right, the sector was hot, the business model was solid the risk and reward outlook looked great. I got in around the 9.24 level and by early July the stock soared to near 11.00. We hit near monthly resistance, a daily sell signal flashed, and I exited the trade around 10.80. Not bad for a three-week swing trade right? In fact, the stock traded back down near 9.50 as I remember, so I felt I really made the right decision.

Well, about a month later as I woke up and turn on the TV the name of the company was in the news, it seemed Dell was interested in acquiring the company. This company went in a bidding war as Hewlett Packard made an offer and this went on back and forth for about a week. The company was finally acquired through a cash tender offer of $33 per share in cash by HPQ. The name of the company was 3 Par.

Did I have remorse? You bet, but one of the greatest things about trading is I know that there will always be another opportunity.

So where are the opportunities now? What will we be looking at and which stocks will we want to revisit?

I am looking at the energy sector, and for good reasons, as Tom points out.

The strong seasonal action is something that has provided good opportunities in previous years. During an interview on February 16, 2010, John was interviewed and two of the stocks that he liked were Exxon Mobil (XOM) and Murphy Oil (MUR). Here is an excerpt from this interview:

The chart of Exxon Mobil (XOM) shows that five days later it dropped to a low of $64.15 and then moved above $66.45 to complete a short term bottom. XOM then rallied to John’s target at $70 by the end of April.

Murphy Oil (MUR bottomed a few days later than XOM on February 25th at $50.32 and started to move higher in March. MUR accelerated to the upside in early April reaching the $62 level by late in the month. This was well over a 20 percent gain in just two months.

This year the seasonal positive bias is supported by several of the energy industry groups which look very strong. The S&P Oil and Gas Refiners & Marketers have just completed a major base formation with this week’s close. The on-balance-volume (OBV) supports the chart formation as it has also broken through major resistance and is now in a very strong uptrend. The next resistance is in the 300-310 area with the major 38.2 percent retracement at 345. This is approximately 38 percent above current levels.

The S&P Oil & Gas Exploration and Producers industry group moved through major resistance at 510 at the end of 2010. This group closed strong last week and looks ready to test the upper trend line channel that is currently in the 615 area. The major 61.8 percent retracement resistance was overcome this week. Any pullback should hold the breakout level.

The daily chart of the Dow Jones Health Care Sector has broken through resistance from the early 2010 highs (line a). The Sector pulled back this week to test the breakout level and came very close to the uptrend that goes back to the September lows. There is resistance from the May 2008 highs at 345 with the previous highs at 367. The daily and weekly OBV are positive as the daily OBV is leading prices higher.

The Mid-cap Health Care sector has already broken out to the upside as it has moved well above both the 2007 and 2010 highs. This confirms the bullish seasonal tendencies we have noticed for the health care sector over the next few months. The completion of this long term trading range has initial targets at 570-600 and then further above 800.

Managed Health Care has completed a long term base on the weekly charts that should have implications for some time. The base formation has targets in the 480-500 area, over 20 percent above current levels. The OBV has just moved through its WMA and appears to have also completed a bottom.

The sectors discussed in this article will be some of the sectors we will be looking hard at in the coming months using our unique filtration methods that incorporate volume, relative performance, and of course Person's Pivot analysis. We are constantly looking for favorable entry points in stocks that our analysis suggests have significant upside potential.

When John and Tom decided to form PA Stock Alerts, they sensed the markets were headed for a period of continued volatility as well as perhaps to remain in a stock pickers' mode rather than a broad based bull market. From the first day of the official launch on July 15, 2010 through the year's end, PA Stock Alerts enjoyed a stellar 29.3 percent return on long stock positions without using leveraged option positions. Their methodology seems to not only stand the test of time, but combined with nearly 70 years of trading experience, it promises to continue to build solid trading returns in the future.

For more information or a free trial please visit www.pastockalerts.com. And be sure to check out John's soon-to-be-released book Trend Trading Indicators: Secrets for Predicting Market Direction from Marketplace Books.